Opinion

Alison Frankel

New ruling puts Fannie, Freddie in line for windfall MBS recovery

Alison Frankel
Dec 17, 2013 20:24 UTC

Has there ever been a more lopsided multibillion-dollar case than the Federal Housing Finance Agency’s fraud litigation against the banks that sold mortgage-backed securities to Fannie Mae and Freddie Mac? I don’t think U.S. District Judge Denise Cote of Manhattan, who is overseeing securities fraud suits against 11 banks that haven’t already settled with the conservator for Fannie and Freddie, has sided with the banks on any major issue, from the timeliness of FHFA’s suits to how deeply the defendants can probe Fannie and Freddie’s knowledge of MBS underwriting standards in the late stages of the housing bubble. But even in that context, Judge Cote’s summary judgment ruling Monday – gutting the banks’ defenses against FHFA’s state-law securities claims – is a doozy.

In effect, Cote’s decision will permit FHFA to recover more from MBS issuers than Fannie Mae and Freddie Mac would have made if their MBS investments had paid as promised. Of course, FHFA and its lawyers at Quinn Emanuel Urquhart & Sullivan and Kasowitz, Benson, Torres & Friedman still have to show that the banks knew or had reason to know that their offering documents misrepresented the mortgage-backed securities they were peddling to Fannie Mae and Freddie Mac. But if FHFA meets that burden, the banks can’t ward off claims under the state securities laws of Virginia and the District of Columbia by blaming Fannie and Freddie’s MBS losses on broad declines in the economy and the housing market.

What’s more, those state securities laws give FHFA the right to rescission – or restitution of the entire purchase price of the MBS Fannie and Freddie bought – plus fees, costs and, most importantly, interest. The Virginia statute mandates that securities fraudsters chip up 6 percent interest – more than the scheduled interest rate in many of the MBS trusts in which Fannie and Freddie invested. The banks, in other words, are now exposed to liability far beyond the actual losses Fannie Mae and Freddie Mac suffered – and even beyond what FHFA’s wards would have earned if the MBS trusts had performed exactly as the banks said they would at the time of sale. That extra interest would be a true windfall for FHFA.

Cote rejected the banks’ motion to ask the Virginia Supreme Court for a ruling on whether the state’s securities fraud law permits a so-called loss causation defense. As the judge explains in her ruling, when Congress passed the Private Securities Litigation Reform Act in 1995, it amended Section 12 of the Securities Act of 1933 to permit defendants to limit their liability by showing that a supposed fraud victim’s losses were not attributable to the defendant’s misrepresentations. In the FHFA cases, the banks’ lawyers – led by James Rouhandeh of Davis Polk & Wardwell, for Morgan Stanley, and Thomas Rice of Simpson, Thacher & Bartlett, for Deutsche Bank – tried to persuade Cote that because state securities laws were based on the federal Securities Act, she should look to the amended federal statute to interpret Virginia and D.C. law. Cote rejected the argument, holding that the federal law did not include a loss causation defense until it was amended in 1995. The Virginia and D.C. laws predate that amendment, Cote said, so loss causation cannot be inferred from their texts.

“As defendants concede, no federal court interpreted the ’33 Act as incorporating a loss causation defense before one was added by the PSLRA,” Cote wrote, so “there is no reason to think the Virginia Supreme Court would read a loss causation defense into the Virginia Securities Act if confronted with the question now.”

Morgan Stanley could be to blame for Detroit’s blight: N.Y. judge

Alison Frankel
Jul 26, 2013 19:08 UTC

In 2012, five African-American Detroit homeowners and a Michigan legal services group asserted a notably creative legal theory in a class action against Morgan Stanley. Their lawyers at Lieff Cabraser Heimann & Bernstein and the American Civil Liberties Union acknowledged that Morgan Stanley didn’t write the supposedly predatory mortgages that victimized African-American borrowers in Detroit. Those housing-bubble mortgages were originated by New Century, a notorious subprime lender that went under in 2007. But the suit argued that New Century was writing loans to feed Morgan Stanley’s securitization machine. Because Morgan Stanley wanted to bundle certain types of subprime loans into its mortgage-backed securities, the theory went, its policies guided New Century’s predatory practices. So according to the homeowners’ suit, Morgan Stanley was actually responsible for the disparate impact of New Century’s discriminatory lending.

Morgan Stanley seemed downright incredulous at the audacity of the suit. Its lawyers at Wilmer Cutler Pickering Hale and Dorr moved to dismiss the class action, stacking up argument after argument about flaws in the homeowners’ legal theory. They’re pretty good arguments, too. The overarching theme of the bank’s defense is that New Century, not Morgan Stanley, is responsible for the loans it wrote. Morgan Stanley didn’t even buy the mortgages of four of the five homeowners who are name plaintiffs in the suit, the motion says, so how can its securitization policies be to blame?

The bank goes on to assert all sorts of technical deficiencies in the plaintiffs’ claims. The homeowners don’t have standing, the Morgan Stanley brief says, because they can’t show they would have qualified for loans on better terms absent discrimination. The plaintiffs waited too long to assert claims, it said, because the statute of limitations under the Fair Housing Act is two years (and under the Equal Credit Opportunity Act, three years), yet the most recent mortgage in the case dates back to 2006. Anti-housing discrimination laws, the bank said, apply to mortgage lenders but not securitizers. And even putting aside all of those arguments, the brief said, the plaintiffs cannot show that Morgan Stanley policies produced a disparate impact on African-Americans in Detroit. Morgan Stanley’s securitization policies were nationwide, not targeted to any racial group in any geographic area, the bank contends, so plaintiffs lawyers improperly cherry-picked Detroit. They also erred in analyzing all New Century lending in Detroit because not all of New Century’s subprime loans were purchased by Morgan Stanley, according to the brief. And finally, any disparate impact from New Century lending, the bank said, is the result of New Century practices that cannot be tied to a specific Morgan Stanley policy.

New brief: Morgan Stanley, rating agencies conspired on 2007 SIV

Alison Frankel
Oct 10, 2012 23:45 UTC

A few months ago, plaintiffs’ lawyers at Robbins Geller Rudman & Dowd created quite a stir when they filed thousands of pages of deposition transcripts and other juicy discovery in an investors’ fraud case against Morgan Stanley, Standard & Poor’s and Moody’s. The documents — exhibits to the investors’ summary judgment motion — included never-before-seen internal communications between Morgan Stanley and the rating agencies as they worked on a structured investment vehicle known as Cheyne, putting on public display the allegedly half-cocked evaluations that Moody’s and S&P performed in 2005, when they were swamped with subprime mortgage-backed financial instruments to rate.

On Wednesday, the Robbins Geller team, led by Daniel Drosman and Luke Brooksfiled a new brief in a parallel case accusing Morgan Stanley, S&P, Moody’s and Fitch of defrauding two pension funds that invested in an SIV called Rhinebridge, which, in contrast to the Cheyne SIV, was sold in July 2007, as the housing bubble was already collapsing. It’s another must-read for students of the financial crisis.

The Rhinebridge brief, which also references all kinds of evidence from inside the bank and the rating agencies, doesn’t have as many notable quotables as the Cheyne filing. But its allegations are, in a way, even grimmer. According to the brief, which opposes motions for summary judgment by Morgan Stanley and the rating agencies, the defendants all knew the end was near for mortgage-backed securities. Yet (again, according to the brief) Morgan Stanley pushed the agencies to deliver high ratings on the Rhinebridge SIV, even as S&P and Moody’s supposedly questioned the percentage of shaky mortgage loans packed into it. Then, despite internal fears that Rhinebridge was too risky to survive, Morgan Stanley allegedly marketed the SIV to Robbins Geller’s clients, mentioning nothing about its concerns the investment would collapse. Just four months after Rhinebridge launched, and two months after the pension funds bought in, the SIV defaulted, en route to being auctioned off at steep losses for investors.

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